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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-Q

(Mark One)


ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2002

or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                              to                             

Commission file number 1-15399


PACKAGING CORPORATION OF AMERICA
(Exact Name of Registrant as Specified in its Charter)

Delaware
(State or other Jurisdiction
of Incorporation or Organization)
  36-4277050
(IRS Employer Identification No.)

1900 West Field Court
Lake Forest, Illinois
(Address of Principal Executive Offices)

 

60045
(Zip Code)

(847) 482-3000
(Registrant's telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)


        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý  No o

        As of November 8, 2002, the Registrant had outstanding 104,446,223 shares of common stock, par value $0.01 per share.





PART I
FINANCIAL INFORMATION

Item 1. Financial Statements.


Packaging Corporation of America

Condensed Consolidated Balance Sheets

 
  September 30, 2002
  December 31, 2001
 
 
  (unaudited)

   
 
(In thousands, except share and per share amounts)              
Assets              
Current assets:              
  Cash and cash equivalents   $ 129,692   $ 82,465  
  Accounts and notes receivable, net of allowance for doubtful accounts of $7,028 and $5,232 as of September 30, 2002 and December 31, 2001, respectively     201,536     170,175  
  Inventories     157,700     170,173  
  Prepaid expenses and other current assets     18,734     12,058  
  Deferred income taxes     40,368     13,346  
   
 
 
    Total current assets     548,030     448,217  

Property, plant and equipment, net

 

 

1,411,595

 

 

1,451,224

 
Intangible assets, net of accumulated amortization of $1,908 and $1,647 as of September 30, 2002 and December 31, 2001, respectively     3,942     4,037  
Other long-term assets     63,313     68,302  
   
 
 
    Total assets   $ 2,026,880   $ 1,971,780  
   
 
 
Liabilities and shareholders' equity              
Current liabilities:              
  Current portion of long-term debt   $ 94   $ 54  
  Accounts payable     94,833     93,873  
  Accrued interest     26,995     13,590  
  Accrued liabilities     85,979     84,378  
   
 
 
    Total current liabilities     207,901     191,895  

Long-term liabilities:

 

 

 

 

 

 

 
  Long-term debt     768,108     795,163  
  Deferred income taxes     245,914     194,452  
  Other liabilities     18,845     20,436  
   
 
 
Total long-term liabilities     1,032,867     1,010,051  

Shareholders' equity:

 

 

 

 

 

 

 
  Common stock (par value $.01 per share, 300,000,000 shares authorized, 104,664,648 shares and 105,570,203 shares issued as of September 30, 2002 and December 31, 2001, respectively)     1,047     1,056  
  Additional paid in capital     470,568     490,915  
  Retained earnings     316,705     280,886  
  Accumulated other comprehensive loss     (1,615 )   (2,967 )
  Common stock held in treasury, at cost (35,000 shares and 3,000 shares at September 30, 2002, and December 31, 2001, respectively)     (593 )   (56 )
   
 
 
    Total shareholders' equity     786,112     769,834  
   
 
 
    Total liabilities and shareholders' equity   $ 2,026,880   $ 1,971,780  
   
 
 

See notes to condensed consolidated financial statements.

2



Packaging Corporation of America

Condensed Consolidated Statements of Income

(unaudited)

 
  Three Months Ended
September 30,

 
 
  2002
  2001
 
(In thousands, except per share amounts)              
Net sales   $ 455,570   $ 455,214  
Cost of sales     (368,953 )   (346,372 )
   
 
 
  Gross profit     86,617     108,842  

Selling and administrative expenses

 

 

(32,895

)

 

(30,633

)
Other expense, net     (3,609 )   (2,536 )
Corporate overhead     (10,078 )   (10,309 )
   
 
 
 
Income before interest and taxes

 

 

40,035

 

 

65,364

 
Interest expense, net     (16,749 )   (17,819 )
   
 
 
 
Income before taxes

 

 

23,286

 

 

47,545

 
Provision for income taxes     (8,688 )   (18,391 )
   
 
 

Net income

 

$

14,598

 

$

29,154

 
   
 
 
Weighted average common shares outstanding:              
  Basic     104,775     106,628  
  Diluted     106,863     109,315  

Basic earnings per common share:

 

 

 

 

 

 

 
  Net income per common share   $ 0.14   $ 0.27  
   
 
 
Diluted earnings per common share:              
  Net income per common share   $ 0.14   $ 0.27  
   
 
 

See notes to condensed consolidated financial statements.

3



Packaging Corporation of America

Condensed Consolidated Statements of Income

(unaudited)

 
  Nine Months Ended
September 30,

 
 
  2002
  2001
 
(In thousands, except per share amounts)              
Net sales   $ 1,317,666   $ 1,376,844  
Cost of sales     (1,072,947 )   (1,048,643 )
   
 
 
 
Gross profit

 

 

244,719

 

 

328,201

 
Selling and administrative expenses     (98,692 )   (92,644 )
Other expense, net     (5,340 )   (3,247 )
Corporate overhead     (30,922 )   (31,432 )
   
 
 
 
Income before interest, taxes and cumulative effect of accounting change

 

 

109,765

 

 

200,878

 
Interest expense, net     (51,231 )   (56,237 )
   
 
 
 
Income before taxes and cumulative effect of accounting change

 

 

58,534

 

 

144,641

 
Provision for income taxes     (22,715 )   (56,114 )
   
 
 
 
Income before cumulative effect of accounting change

 

 

35,819

 

 

88,527

 
Cumulative effect of accounting change, net of tax         (495 )
   
 
 

Net income

 

$

35,819

 

$

88,032

 
   
 
 
Weighted average common shares outstanding:              
  Basic     105,257     106,543  
  Diluted     107,475     109,114  

Basic earnings per common share:

 

 

 

 

 

 

 
  Income before cumulative effect of accounting change   $ 0.34   $ 0.83  
  Cumulative effect of accounting change          
   
 
 
  Net income per common share   $ 0.34   $ 0.83  
   
 
 
Diluted earnings per common share:              
  Income before cumulative effect of accounting change   $ 0.33   $ 0.81  
  Cumulative effect of accounting change          
   
 
 
  Net income per common share   $ 0.33   $ 0.81  
   
 
 

See notes to condensed consolidated financial statements.

4



Packaging Corporation of America

Condensed Consolidated Statements of Cash Flow

(unaudited)

 
  Nine Months Ended
September 30,

 
 
  2002
  2001
 
(In thousands)              
Cash Flows from Operating Activities:              
Net income   $ 35,819   $ 88,032  
   
 
 
Adjustments to reconcile net income to net cash provided by operating activities:              
  Depreciation, depletion and amortization     111,115     105,230  
  Amortization of financing costs     3,181     3,662  
  Cumulative effect of accounting change         495  
  Increase in deferred income taxes     23,569     30,808  
  (Gain) loss on sales/disposals of property, plant and equipment     3,264     (937 )
  Tax benefit associated with employee stock option exercises     3,449      
  Other, net     2,216     4,944  
Changes in components of working capital:              
  (Increase) decrease in current assets—              
    Accounts receivable     (31,413 )   (5,400 )
    Inventories     12,473     2,998  
    Prepaid expenses and other     (6,702 )   (4,715 )
  Increase (decrease) in current liabilities—              
    Accounts payable     1,202     (1,797 )
    Accrued liabilities     14,177     13,725  
   
 
 
      Net cash provided by operating activities     172,350     237,045  
   
 
 
Cash Flows from Investing Activities:              
  Additions to property, plant and equipment     (72,363 )   (96,001 )
  Additions to other long term assets     (5,354 )   (2,537 )
  Acquisition of business         (4,827 )
  Proceeds from disposals of property, plant and equipment     2,653     1,044  
  Other, net     1,330     884  
   
 
 
      Net cash used for investing activities     (73,734 )   (101,437 )
   
 
 
Cash Flows from Financing Activities:              
Payments on long-term debt     (27,046 )   (53,239 )
Repurchases of common stock     (27,844 )   (30,102 )
Issuance of common stock upon exercise of stock options     3,501     5,138  
   
 
 
      Net cash used for financing activities     (51,389 )   (78,203 )
   
 
 
Net increase in cash     47,227     57,405  
Cash and cash equivalents, beginning of period     82,465     7,892  
   
 
 
Cash and cash equivalents, end of period   $ 129,692   $ 65,297  
   
 
 

See notes to condensed consolidated financial statements.

5



Packaging Corporation of America

Notes to Condensed Consolidated Financial Statements

(unaudited)
September 30, 2002

1.    Basis of Presentation

        The consolidated financial statements as of September 30, 2002 and 2001 of Packaging Corporation of America ("PCA" or the "Company") are unaudited but include all adjustments (consisting only of normal recurring adjustments) that management considers necessary for a fair presentation of such financial statements. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with Article 10 of SEC Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. Operating results during the period ended September 30, 2002 are not necessarily indicative of the results that may be expected for the period ending December 31, 2002. These consolidated financial statements should be read in conjunction with PCA's annual report on Form 10-K for the year ended December 31, 2001.

2.    Summary of Accounting Policies

Basis of Consolidation

        The accompanying condensed consolidated financial statements of PCA include all majority-owned subsidiaries. All significant intercompany transactions have been eliminated. The Company has one joint venture that is carried under the equity method.

Use of Estimates

        The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts in the financial statements and the accompanying notes. Actual results could differ from those estimates.

Segment Information

        PCA is primarily engaged in one line of business: the manufacture and sale of packaging materials, boxes and containers for industrial and consumer markets. No single customer accounts for more than 10% of total revenues. PCA's manufacturing operations are located within the United States.

New Accounting Pronouncements

        Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." Under the new rules, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests. Other intangible assets will continue to be amortized over their useful lives. Application of the provisions of the Statements did not have a material impact on the Company's consolidated financial position or results of operations. No goodwill amortization was incurred during the year ended December 31, 2001. On September 30, 2002, the Company had $2.1 million of other intangible assets subject to amortization and $1.8 million of goodwill.

        Effective January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which addresses financial accounting and reporting for the impairment

6



or disposal of long-lived assets and supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations" for a disposal of a segment of a business. The adoption of SFAS No. 144 on January 1, 2002, did not have a material impact on the Company's consolidated financial position or results of operations.

        In June 2001, the Financial Accounting Standards Board issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which is effective for fiscal years beginning after June 15, 2002. The Statement requires legal obligations associated with the retirement of long-lived assets to be recognized at their fair value at the time that the obligations are incurred. Upon initial recognition of a liability, that cost should be capitalized as part of the related long-lived asset and allocated to expense over the useful life of the asset. The Company will adopt the new rules on asset retirement obligations on January 1, 2003. The adoption of the Statement is not expected to have a material impact on the Company's financial statements.

Revenue Recognition

        The Company recognizes revenue as title to the products is transferred to customers. Shipping and handling costs are included in cost of sales. Shipping and handling billings to a customer in a sales transaction are included in revenue.

Comprehensive Income

        For the nine months ended September 30, 2002 and 2001, total comprehensive income was $1.4 million greater and $3.4 million less, respectively, than net income for the respective periods due to changes in the fair value of derivatives.

Reclassifications

        Prior year's financial statements have been reclassified where appropriate to conform with current year presentation.

7



3.    Earnings Per Share

        The following table sets forth the computation of basic and diluted income per common share for the periods presented.


 


 

Three Months Ended
September 30,

 
  2002
  2001
(In thousands, except per share data)

Numerator:            
  Net income   $ 14,598   $ 29,154
Denominator:            
  Basic common shares outstanding     104,775     106,628
Effect of dilutive securities:            
  Stock options     2,088     2,687
   
 
Dilutive common shares outstanding     106,863     109,315
Basic income per common share   $ 0.14   $ 0.27
Diluted income per common share   $ 0.14   $ 0.27

 


 

Nine Months Ended
September 30,

 
  2002
  2001
(In thousands, except per share data)

Numerator:            
  Net income   $ 35,819   $ 88,032
Denominator:            
  Basic common shares outstanding     105,257     106,543
Effect of dilutive securities:            
  Stock options     2,218     2,571
   
 
Dilutive common shares outstanding     107,475     109,114
Basic income per common share   $ 0.34   $ 0.83
Diluted income per common share   $ 0.33   $ 0.81

8


4.    Inventories

        The components of inventories are as follows:


 


 

September 30, 2002

 

December 31, 2001


 
 
   
  (audited)

 
(In thousands)

 
Raw materials   $ 71,627   $ 82,540  
Work in progress     5,273     5,989  
Finished goods     48,169     46,942  
Supplies and materials     59,027     58,118  
   
 
 
Inventories at FIFO cost     184,096     193,589  
Excess of FIFO over LIFO cost     (26,396 )   (23,416 )
   
 
 
Inventory, net   $ 157,700   $ 170,173  
   
 
 

        An actual valuation of inventory under the LIFO method can be made only at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations must necessarily be based on management's estimates of expected year-end inventory levels and costs. Because these are subject to many forces beyond management's control, interim results are subject to the final year-end LIFO inventory valuation.

5.    Shareholders' Equity

        On May 16, 2001, the Company announced a $100.0 million common stock repurchase program. PCA currently expects to continue to repurchase the shares from time to time. Through September 30, 2002, the Company repurchased 3,907,100 shares of common stock for approximately $66.2 million. Of the 3,907,100 shares repurchased, 385,100 shares, 120,100 shares and 1,078,700 shares were repurchased during the first, second and third quarters, respectively, of 2002, for approximately $27.8 million. All shares were retired prior to September 30, 2002, except for 35,000 shares which were retired October 1, 2002.

6.    Summarized Combined Financial Information about Guarantor Subsidiaries

        The following is summarized aggregated financial information for Packaging Credit Company, LLC, Dixie Container Corporation, PCA International, Inc., and PCA Hydro, Inc., each of which was a wholly-owned subsidiary of PCA and included in the Company's consolidated financial statements. Each of these subsidiaries fully, unconditionally, jointly and severally guaranteed $550.0 million in senior subordinated notes issued by PCA. Separate financial statements of the guarantor subsidiaries are not presented because, in the opinion of management, such financial statements are not material to

9



investors. Financial information for Packaging Receivables Company, LLC is reflected as a non-guarantor subsidiary.


 


 

PCA

 

Guarantor
Subs


 

Non-Guarantor
Sub


 

Eliminations


 

Total

(In thousands)                              
September 30, 2002                              
  Current assets   $ 378,639   $ 58,747   $ 195,605   $ (84,961 ) $ 548,030
  Non-current assets     1,604,573     157,669         (283,392 )   1,478,850
   
 
 
 
 
    Total assets     1,983,212     216,416     195,605     (368,353 )   2,026,880
  Current liabilities     324,722     3,545     101     (120,467 )   207,901
  Non-current liabilities     919,502     365     113,000         1,032,867
   
 
 
 
 
    Total liabilities     1,244,224     3,910     113,101     (120,467 )   1,240,768
   
 
 
 
 
  Net assets   $ 738,988   $ 212,506   $ 82,504   $ (247,886 ) $ 786,112
   
 
 
 
 

December 31, 2001

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Current assets   $ 260,573   $ 62,264   $ 204,370   $ (78,990 ) $ 448,217
  Non-current assets     1,649,244     114,932         (240,613 )   1,523,563
   
 
 
 
 
    Total assets     1,909,817     177,196     204,370     (319,603 )   1,971,780
  Current liabilities     288,009     2,651     100     (98,865 )   191,895
  Non-current liabilities     883,799     252     126,000         1,010,051
   
 
 
 
 
    Total liabilities     1,171,808     2,903     126,100     (98,865 )   1,201,946
   
 
 
 
 
  Net assets   $ 738,009   $ 174,293   $ 78,270   $ (220,738 ) $ 769,834
   
 
 
 
 

Nine months ended September 30, 2002

 

 

 

 

 

 

 

 

 

 

 

 
  Net sales   $ 1,311,677   $ 5,989   $   $   $ 1,317,666
  Pre-tax profit     33,390     62,924     192     (37,972 )   58,534
  Net income     20,520     38,210     192     (23,103 )   35,819
Nine months ended September 30, 2001                        
  Net sales   $ 1,373,882   $ 2,962   $   $   $ 1,376,844
  Pre-tax profit     121,710     48,114     5,519     (30,702 )   144,641
  Net income     73,746     27,893     5,519     (19,126 )   88,032

10



Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations.

Results of Operations

Three Months Ended September 30, 2002 Compared to Three Months Ended September 30, 2001

Net Sales

        Net sales increased by $0.4 million, or 0.1%, for the three months ended September 30, 2002 from the comparable period in 2001. The increase was primarily the result of increased sales volumes of corrugated products and containerboard to external third parties, but was almost entirely offset by decreased sales prices of corrugated products and containerboard.

        Total corrugated products volume increased 6.5% per workday for the three months ended September 30, 2002 from the comparable period in 2001, with August's volume per workday an all-time record for PCA. This volume improvement represented the best year-over-year quarterly increase in volume per workday since the second quarter of 1999, when volume per workday increased 8.5% compared to the second quarter of 1998. Containerboard volume to external domestic and export customers increased 2.1% for the three months ended September 30, 2002 from the comparable period in 2001. Containerboard mill production for the three months ended September 30, 2002 was 578,000 tons compared to 561,000 tons in the same period in 2001 and 548,000 tons in the second quarter of 2002.

        According to Pulp & Paper Week, average linerboard and semi-chemical medium prices for 42 lb. Liner-East and 26 lb. Medium-East, which are representative benchmark grades, were $428 and $387, respectively, per ton for the three months ended September 30, 2002. This compares to $445 and $400, respectively, per ton for the three months ended September 30, 2001. Pulp & Paper Week's published pricing typically applies to transactions that occur in the month following the publication. Accordingly, the average price for the third quarter consists of the average of the prices published in June, July and August.

        Pulp & Paper Week reported that average linerboard and semi-chemical medium prices for 42 lb. Liner-East and 26 lb. Medium-East increased $20 to $435 and $25 to $395, respectively, per ton in July. In September, Pulp & Paper Week reported that linerboard prices increased an additional $5 to $440 per ton. With respect to box prices, PCA realized about a $10 per ton increase in August and another $10 per ton increase in September. As a result, PCA realized an average box price increase of $10 per ton in the third quarter. PCA realized an approximate increase of an additional $8 to $9 per ton in box prices during October.

Income Before Interest Expense and Taxes

        Operating income decreased by $25.3 million, or 38.8%, for the three months ended September 30, 2002 compared to the three months ended September 30, 2001. The decrease in operating income was primarily attributable to the lower sales prices described above in addition to increased recycled fiber costs at our containerboard mills, partially offset by higher sales volumes of corrugated products and containerboard to external third parties.

        Gross profit decreased $22.2 million, or 20.4%, for the three months ended September 30, 2002 from the comparable period in 2001. Gross profit as a percentage of sales declined from 23.9% of sales to 19.0% of sales in the current quarter due primarily to the lower sales prices and increased recycled fiber costs described previously.

        Selling and administrative expenses increased $2.3 million, or 7.4%, for the three months ended September 30, 2002 compared to the three months ended September 30, 2001. The increase was primarily the result of increased salary, medical and other general selling related expenses.

11



        Corporate overhead for the three months ended September 30, 2002 decreased by $0.2 million, or 2.2%, from the comparable period in 2001. The decrease was primarily attributable to reduced expenses related to information technology.

Interest Expense and Income Taxes

        Interest expense decreased by $1.1 million, or 6.0%, for the three months ended September 30, 2002 from the three months ended September 30, 2001, primarily as a result of prepayments PCA made in 2001 and during the first quarter of 2002 on the term loans under its senior credit facility and the receivables credit facility.

        PCA's effective tax rate was 37.3% for the three months ended September 30, 2002 and 38.7% for the comparable period in 2001. The effective tax rate varies from the U.S. federal statutory tax rate of 35% principally due to the impact of state and local income taxes and a deduction for extraterritorial income exclusion.

Net Income

        Net income decreased by $14.6 million, or 49.9%, for the three months ended September 30, 2002 from the three months ended September 30, 2001. The decrease was primarily the result of lower sales prices for both containerboard and corrugated products ($14.2 million after tax, or $0.13 per share) and increased recycled fiber costs at our containerboard mills ($3.8 million after tax, or $0.035 per share), partially offset by higher sales volumes of corrugated products and containerboard to external third parties ($4.0 million after tax, or $0.04 per share).

Nine Months Ended September 30, 2002 Compared to Nine Months Ended September 30, 2001

Net Sales

        Net sales decreased by $59.2 million, or 4.3%, for the nine months ended September 30, 2002 from the comparable period in 2001. The decrease was primarily the result of decreased sales prices of containerboard and corrugated products partially offset by increased sales volumes of corrugated products and containerboard to external third parties.

        Total corrugated products volume increased 3.6% for the nine months ended September 30, 2002 from the comparable period in 2001. On a comparable shipments-per-workday basis, corrugated products volume was up 4.2% from the first nine months of 2001. The first nine months of 2002 had one less workday, those days not falling on a weekend or holiday, than the first nine months of 2001. Containerboard volume to external domestic and export customers increased 3.5%. Our containerboard mill production for the nine months ended September 30, 2002 was 1,646,000 tons compared to 1,582,000 tons in the same period in 2001.

        According to Pulp & Paper Week, average linerboard and semi-chemical medium prices for 42 lb. Liner-East and 26 lb. Medium-East, which are representative benchmark grades, were $421 and $378, respectively, per ton for the nine months ended September 30, 2002. This compares to $455 and $416, respectively, per ton for the nine months ended September 30, 2001.

        Pulp & Paper Week reported that average linerboard and semi-chemical medium prices for 42 lb. Liner-East and 26 lb. Medium-East increased $20 to $435 and $25 to $395, respectively, per ton in July. In September, Pulp & Paper Week reported that linerboard prices increased an additional $5 to $440 per ton. With respect to box prices, PCA realized about a $10 per ton increase in August and another $10 per ton increase in September. As a result, PCA realized an average box price increase of $10 per ton in the third quarter. PCA realized an approximate increase of an additional $8 to $9 per ton in box prices during October.

12



Income Before Interest Expense and Taxes

        Operating income decreased by $91.1 million, or 45.4%, for the nine months ended September 30, 2002 compared to the nine months ended September 30, 2001. The decrease in operating income was primarily attributable to the lower sales prices described above in addition to increased recycled fiber costs at the containerboard mills partially offset by higher sales volumes of corrugated products and containerboard to external third parties.

        Gross profit decreased $83.5 million, or 25.4%, for the nine months ended September 30, 2002 from the comparable period in 2001. Gross margins decreased to 18.6% of sales in the first nine months of 2002 from 23.8% of sales in the first nine months of 2001 due primarily to the lower sales prices and increased recycled fiber costs described previously.

        Selling and administrative expenses increased $6.0 million, or 6.5%, for the nine months ended September 30, 2002 compared to the nine months ended September 30, 2001. The increase was primarily the result of increased salary, medical and other general selling related expenses.

        Corporate overhead for the nine months ended September 30, 2002 decreased by $0.5 million, or 1.6%, from the comparable period in 2001. The decrease was primarily due to reduced expenses related to information technology, treasury, legal and investor relations matters.

Interest Expense and Income Taxes

        Interest expense decreased by $5.0 million, or 8.9%, for the nine months ended September 30, 2002 from the nine months ended September 30, 2001, primarily as a result of prepayments PCA made in 2001 and during the first quarter of 2002 on the term loans under its senior credit facility and the receivables credit facility.

        PCA's effective tax rate was 38.8% for the nine months ended September 30, 2002 and 38.8% for the comparable period in 2001. The effective tax rate varies from the U.S. federal statutory tax rate of 35% principally due to the impact of state and local income taxes.

Net Income

        Net income decreased by $52.2 million, or 59.3%, for the nine months ended September 30, 2002 from the nine months ended September 30, 2001. The decrease was primarily the result of lower sales prices ($57.5 million after tax, or $0.54 per share) and increased recycled fiber costs at our containerboard mills ($4.9 million after tax, or $0.05 per share) partially offset by higher sales volumes of corrugated products and containerboard to external third parties ($11.8 million after tax, or $0.11 per share).

Liquidity and Capital Resources

Operating Activities

        Cash flow provided by operating activities for the nine months ended September 30, 2002 was $172.4 million, a decrease of $64.7 million, or 27.3%, from the comparable period in 2001. The decrease was primarily due to lower net income as a result of decreased sales prices of containerboard and corrugated products, as well as decreased deferred income taxes and unfavorable changes in working capital. The unfavorable changes in working capital were driven by higher balances of accounts receivable related to the strong sales volumes described previously, partially offset by lower inventory levels.

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Investing Activities

        Net cash used for investing activities for the nine months ended September 30, 2002 decreased $27.7 million, or 27.3%, to $73.7 million, compared to the nine months ended September 30, 2001. The reduction was primarily a result of decreased additions to property, plant and equipment and one business acquisition in the second quarter of 2001.

Financing Activities

        Net cash used for financing activities totaled $51.4 million for the nine months ended September 30, 2002, a decrease of $26.8 million, or 34.3%, from the comparable period in 2001. The decrease was primarily attributable to decreased debt prepayments.

        The following table provides the outstanding balance and the weighted average interest rate as of September 30, 2002 for each of PCA's outstanding term loans, revolving credit facility and receivables credit facility:

 
  Balance at
September 30, 2002

  Weighted
Average
Interest Rate

Borrowing Arrangement (in thousands)          
Term Loan A   $ 72,593   6.45%
Term Loan B     32,407   6.95%
Senior Revolving Credit Facility:          
  Revolver—Eurodollar       N/A
  Revolver—Base Rate       N/A
Receivables Credit Facility     113,000   4.24%
   
 

Total

 

$

218,000

 

5.38%
   
 

        In addition to the term loans and other borrowing arrangements noted above, PCA has $550 million of 95/8% senior subordinated notes due 2009.

        The borrowings under the senior revolving credit facility are available to fund PCA's working capital requirements, capital expenditures and other general corporate purposes. The senior revolving credit facility will terminate in 2006. The Term Loan A must be repaid in quarterly installments from March 2004 through June 2006. The Term Loan B must be repaid in quarterly installments from December 2004 through June 2007. The receivables credit facility will terminate in November 2003. As of September 30, 2002, PCA had $150.0 million in availability and no borrowings outstanding under the senior revolving credit facility. Under the receivables credit facility, PCA had $37.0 million in availability and $113.0 million outstanding as of September 30, 2002.

        The instruments governing PCA's indebtedness contain financial and other covenants that restrict, among other things, the ability of PCA and its subsidiaries to:

        These limitations could limit corporate and operating activities.

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        In addition, we must maintain minimum debt service, minimum net worth and maximum leverage ratios under the senior credit facility. A failure to comply with the restrictions contained in the senior credit facility could lead to an event of default, which could result in an acceleration of such indebtedness. Such an acceleration would also constitute an event of default under the notes indenture and the receivables credit facility.

        PCA estimates that it will make approximately $110.0 million in capital expenditures in 2002. These expenditures will be used primarily for maintenance capital, cost reduction, business growth and environmental compliance. As of September 30, 2002, PCA had spent $72.4 million for capital expenditures and had committed to spend an additional $38.0 million.

        PCA believes that cash generated from operations will be adequate to meet its anticipated debt service requirements, capital expenditures and working capital needs for the next 12 months, and that cash generated from operations and amounts available under the senior revolving credit facility will be adequate to meet its anticipated debt service requirements, capital expenditures and working capital needs for the foreseeable future. PCA's future operating performance and its ability to service or refinance the notes, to service, extend or refinance the credit facilities and to pay cash dividends, will be subject to future economic conditions and to financial, business and other factors, many of which are beyond PCA's control.

Market Risk and Risk Management Policies

        PCA currently has interest rate collar agreements that protect against rising interest rates and simultaneously guarantee a minimum interest rate. The notional amount of these collar agreements was $175.0 million as of September 30, 2002. The weighted average floor of the interest rate collar agreements is 5.02% and the weighted average ceiling of the interest rate collar agreements is 6.85%. The interest rate on approximately 80% of PCA's variable-rate debt as of September 30, 2002 was capped. PCA receives payments under the collar agreements if the applicable interest rate (LIBOR or commercial paper) exceeds the ceiling. Correspondingly, PCA makes payments under the collar agreements if the applicable interest rate drops below the floor. In both cases, the amounts received or paid are based upon the notional amount and the difference between the actual interest rate and the ceiling or floor rate. The weighted average duration of the interest rate collar agreements is approximately seven months.

        As a result of the collar agreements noted above and the interest rate environment, a one percent increase in interest rates would result in an increase in interest expense and a corresponding decrease in income before taxes of approximately $0.4 million annually. As of September 30, 2002, the weighted average LIBOR rate was 1.79% and the weighted average commercial paper rate was 1.84%. The effect of an interest rate change to the fair market value of the outstanding debt is insignificant. This analysis does not consider any other impact on fair value that could exist in such an interest rate environment. In the event of a change in interest rates, management could take actions to further mitigate its exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, the sensitivity analysis assumes no changes in PCA's financial structure.

Environmental Matters

        PCA is subject to, and must comply with, a variety of federal, state and local environmental laws, particularly those relating to air and water quality, waste disposal and the cleanup of contaminated soil and groundwater. Because environmental regulations are constantly evolving, PCA has incurred, and will continue to incur, costs to maintain compliance with those laws. In particular, the United States Environmental Protection Agency recently finalized the Cluster Rules, which govern pulp and paper mill operations, including those at our Counce, Filer City, Valdosta and Tomahawk mills. Over the next

15



several years, the Cluster Rules will affect PCA's allowable discharges of air and water pollutants, and require PCA to spend money to ensure compliance with those new rules.

Impact of Inflation

        PCA does not believe that inflation has had a material impact on its financial position or results of operations during the past three years.

Critical Accounting Policies

        Management's discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to bad debts, inventories, intangible assets, pensions and other post-retirement benefits, income taxes, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

        We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. For a detailed discussion on the application of these and other accounting policies, see Note 2 to our audited consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2001.

Accounts Receivable

        We evaluate the collectibility of our accounts receivable based upon a combination of factors. In circumstances where we are aware of a specific customer's inability to meet its financial obligations to us (e.g., bankruptcy filings, substantial downgrading of credit sources), we record a specific reserve for bad debts against amounts due to reduce the net recognized receivable to the amount we reasonably believe will be collected. During the second and third quarters of 2002, PCA recorded an additional $1.6 million reserve for bad debts related to customers who entered into bankruptcy proceedings. For all other customers, we recognize reserves for bad debts based on the length of time the receivables are past due ranging from 0.1% for current amounts to 20% for amounts more than 90 days past due based on our historical experience. If our collection experience deteriorates (e.g., higher than expected defaults or an unexpected material adverse change in a major customer's ability to meet its financial obligations to us), our estimates of the recoverability of amounts due us could be reduced by a material amount.

Inventory

        We record our inventory at the lower of cost or market. The estimated market value is based on assumptions for future demand and related pricing. If actual market conditions are less favorable than those projected by management, reductions in the value of inventory may be required. Raw materials, work in process and finished goods are valued using the lower of last-in, first-out ("LIFO") cost or market method. Supplies and materials inventories are valued using a moving average cost.

Derivatives

        We hold derivative financial instruments to hedge our interest rate risk associated with our variable rate long-term debt. These derivatives qualify for hedge accounting as discussed in Note 2 to our

16



audited consolidated financial statements included in our most recent annual report on Form 10-K. We do not speculate in derivatives trading. Hedge accounting results when we designate and document the hedging relationships involving these derivative instruments. While we intend to continue to meet the conditions for hedge accounting, if hedges do not qualify as highly effective or if we did not believe that forecasted transactions would occur, the changes in the fair value of the derivatives used as hedges would be reflected in earnings.

        To hedge interest rate risk, interest rate collars are used to protect against rising interest rates and simultaneously guarantee minimum interest rates related to our variable rate debt. These instruments are valued using the market standard methodology of netting the discounted future cash receipts and cash payments. The cash receipts and cash payments are based on an expectation of future interest rates derived from observed market interest rate curves. We have not changed our methods of calculating these fair values or developing the underlying assumptions. The values of these derivatives will change over time as cash receipts and payments are made and as market conditions change. Information about the fair values, notional amounts, and contractual terms of these instruments can be found in Notes 6 and 7 to our audited consolidated financial statements included in our most recent annual report on Form 10-K and the section titled "Quantitative and Qualitative Disclosures About Market Risk" included elsewhere in this report.

        In addition to the above derivative financial instruments, we have other contracts covering a portion of our purchases of natural gas and electricity that have the characteristics of derivatives but are not required to be accounted for as derivatives. These contracts for the physical delivery of these items qualify for the normal purchases exception under SFAS No. 133 as we take physical delivery of the item and use it in the production process. This exception is an election and, if not elected, these contracts would be carried on the balance sheet at fair value with changes in fair value reflected in income. These contracts cover natural gas and electricity usage at our mills through 2004.

Environmental Liabilities

        The estimated landfill closure and postclosure maintenance costs expected to be incurred upon and subsequent to the closing of existing operating landfill areas are accrued based on the landfill capacity used to date. Amounts are estimates using current technologies for closure and monitoring and are not discounted.

        The potential costs for various environmental matters are uncertain due to such factors as the unknown magnitude of possible cleanup costs, the complexity and evolving nature of governmental laws and regulations and their interpretations, and the timing, varying costs and effectiveness of alternative cleanup technologies. Liabilities recorded for environmental contingencies are estimates of the probable costs based upon available information and assumptions. Because of these uncertainties, however, our estimates may change. We believe that any additional costs identified as further information becomes available would not have a material effect on our financial statements.

        In connection with the sale to PCA of the containerboard and corrugated products business of Pactiv Corporation in April 1999, Pactiv agreed to retain all liability for all former facilities and all sites associated with offsite waste disposal prior to April 12, 1999. Pactiv also retained environmental liability for a closed landfill located near the Filer City mill.

Debt Covenants

        Our senior credit facility requires us to maintain minimum debt service, minimum net worth, and maximum leverage ratios as discussed in Note 6 to our audited consolidated financial statements included in our most recent annual report on Form 10-K. As of September 30, 2002, we were in compliance with these covenants. A failure to comply with the restrictions contained in the senior credit facility could lead to an event of default, which could result in an acceleration of such

17



indebtedness. Due to cross-default provisions contained in the notes indenture and the receivables credit facility, all of our debt could become due in full if any of our debt is in default. Given our results of our operations for the nine months ended September 30, 2002 and our projections for future operating results, defaulting on our debt covenants is unlikely absent any material negative event affecting the U.S. economy as a whole. We also believe our lenders would provide us waivers if necessary. However, our expectations of future operating results and continued compliance with our debt covenants cannot be assured and we cannot control our lenders. If our projections of future operating results are not achieved and our debt is placed in default, we could experience a material adverse impact on our reported financial position and results of operations.

Revenue Recognition

        We recognize revenue as title to the products is transferred to customers.

Impairment of Long-Lived Assets

        Long-lived assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. In the event that facts and circumstances indicate that the carrying amount of any long-lived assets may be impaired, an evaluation of recoverability would be performed. If an evaluation were required, the estimated future undiscounted cash flows associated with the asset would be compared to the asset's carrying amount to determine if a write-down to discounted cash flows was required.

Forward-Looking Statements

        Some of the statements in this Quarterly Report on Form 10-Q are forward-looking statements. Forward-looking statements include statements about our future financial condition, our industry and our business strategy. Statements that contain words such as "anticipate," "believe," "expect," "intend," "estimate," "hope" or similar expressions, are forward-looking statements. These forward-looking statements are based on the current expectations of PCA. Because forward-looking statements involve inherent risks and uncertainties, the plans, actions and actual results of PCA could differ materially. Among the factors that could cause plans, actions and results to differ materially from PCA's current expectations are those identified under the caption "Risk Factors" in PCA's Registration Statements on Form S-4 and Form S-1, each filed with the Securities and Exchange Commission and available at the SEC's website at "www.sec.gov".


Item 3.    Quantitative and Qualitative Disclosures about Market Risk.

        For a discussion of market risks related to PCA, see Part I, Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations—Market Risk and Risk Management Policies" in this Quarterly Report on Form 10-Q.


Item 4.    Controls and Procedures.

        PCA's Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of PCA's disclosure controls and procedures, as defined in Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934, as of a date within 90 days of the filing date of this quarterly report and concluded that PCA's disclosure controls and procedures were functioning properly as of the evaluation date.

        Based on this most recent evaluation, there do not appear to have been any significant changes in PCA's internal controls or in other factors that could significantly affect these controls subsequent to the date of this evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. The results of this evaluation have been discussed with PCA's Audit Committee and with Ernst & Young LLP, PCA's independent auditors.

18




PART II
OTHER INFORMATION

Item 1.    Legal Proceedings.

        On May 14, 1999, PCA was named as a defendant in a Consolidated Class Action Complaint which alleged a civil violation of Section 1 of the Sherman Act. The suit, captioned Winoff Industries, Inc. v. Stone Container Corporation, MDL No. 1261 (E.D. Pa.), names us as a defendant based solely on the allegation that PCA is successor to the interests of Tenneco Packaging Inc. and Tenneco Inc., both of which were also named as defendants in the suit, along with nine other linerboard manufacturers. The complaint alleges that the defendants, during the period October 1, 1993 through November 30, 1995, conspired to limit the supply of linerboard, and that the purpose and effect of the alleged conspiracy was artificially to increase prices of corrugated containers. The plaintiffs moved to certify a class of all persons in the United States who purchased corrugated containers directly from any defendant during the above period, and seek treble damages and attorneys' fees on behalf of the purported class. The Court granted plaintiffs' motion on September 4, 2001, but modified the proposed class to exclude those purchasers who purchased corrugated containers pursuant to contracts in which the price was "not tied to the price of linerboard." The Court's class certification decision was affirmed by the Court of Appeals for the Third Circuit on September 5, 2002. The case is currently set for trial in April, 2004. PCA believes that the plaintiffs' allegations have no merit and intends to defend against the suit vigorously. PCA does not believe that the outcome of this litigation should have a material adverse effect on its financial position, results of operations, or cash flow.

        PCA is also party to various legal actions arising in the ordinary course of our business. These legal actions cover a broad variety of claims spanning our entire business. PCA believes that the resolution of these legal actions will not, individually or in the aggregate, have a material adverse effect on its financial condition or results of operations.


Item 2.    Changes in Securities and Use of Proceeds

        None.


Item 3.    Defaults Upon Senior Securities

        None.


Item 4.    Submission of Matters to a Vote of Security Holders

        None.


Item 5.    Other Information

        None.


Item 6.    Exhibits and Reports on Form 8-K

1) Exhibits    
 
99.1

 

Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. §1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

2) Reports on Form 8-K

 

 

On August 13, 2002, PCA filed a current report on Form 8-K furnishing the sworn statements of the Chief Executive Officer and Chief Financial Officer in accordance with Order No. 4-460 and pursuant to Section 21(a)(1) of the Securities Exchange Act of 1934.

19



SIGNATURE

        Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


 

 

PACKAGING CORPORATION OF AMERICA
    (Registrant)

 

 

By:

 

/s/  
PAUL T. STECKO      
Chairman and Chief Executive Officer
(Authorized Officer)

 

 

By:

 

/s/  
RICHARD B. WEST      
Senior Vice President, Chief Financial Officer,
and Corporate Secretary
(Principal Financial Officer)

Date: November 13, 2002

 

 

 

 

20


CERTIFICATIONS

        I, Paul T. Stecko, certify that:

        (1)  I have reviewed this quarterly report on Form 10-Q of Packaging Corporation of America;

        (2)  Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

        (3)  Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of Packaging Corporation of America as of, and for, the periods presented in this quarterly report;

        (4)  PCA's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for PCA and we have:

        (5)  PCA's other certifying officer and I have disclosed, based on our most recent evaluation, to PCA's auditors and the Audit Committee of PCA's Board of Directors (or persons performing the equivalent function):

        (6)  PCA's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

/s/ Paul T. Stecko

Paul T. Stecko
Chairman and Chief Executive Officer

November 13, 2002


        I, Richard B. West, certify that:

        (1)  I have reviewed this quarterly report on Form 10-Q of Packaging Corporation of America;

        (2)  Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

        (3)  Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of Packaging Corporation of America as of, and for, the periods presented in this quarterly report;

        (4)  PCA's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for PCA and we have:

        (5)  PCA's other certifying officer and I have disclosed, based on our most recent evaluation, to PCA's auditors and the Audit Committee of PCA's Board of Directors (or persons performing the equivalent function):

        (6)  PCA's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

/s/ Richard B. West

Richard B. West
Senior Vice President, Chief Financial Officer
and Corporate Secretary

November 13, 2002




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PART I FINANCIAL INFORMATION
PART II OTHER INFORMATION
SIGNATURE

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Exhibit 99.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
PURSUANT TO 18 U.S.C. §1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

        I, Paul T. Stecko, hereby certify pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

        (1)  The Quarterly Report of Packaging Corporation of America (the "Company") on Form 10-Q for the period ended September 30, 2002 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

        (2)  The information contained in such Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Paul T. Stecko

Paul T. Stecko
Chairman and Chief Executive Officer

November 13, 2002

        I, Richard B. West, hereby certify pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

        (1)  The Quarterly Report of Packaging Corporation of America (the "Company") on Form 10-Q for the period ended September 30, 2002 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

        (2)  The information contained in such Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Richard B. West

Richard B. West
Senior Vice President, Chief Financial Officer
and Corporate Secretary

November 13, 2002




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